Got this email (no doubt circulating):
Understanding the banking and derivative markets (and some parts of the horse business)
“See if this makes more sense. Josh Coles, a nutjob, is the proprietor of a bar in Lexington. In order to increase sales, he decides to allow his loyal customers — most of whom are unemployed alcoholics — to drink now but pay later. He keeps track of the drinks consumed on a ledger (thereby granting the customers loans). Word gets around about Coles’ “Drink Now, Pay Later” marketing strategy and as a result, increasing numbers of customers flood into Josh’s bar and soon he has the largest sale volume for any bar in Lexington. By providing his customers freedom from immediate payment demands, Coles gets no resistance when he substantially increases his prices for wine and beer, the most consumed beverages. With profits, he then gets into the horse breeding business, specializing in Illinois-breds.
“His sales volume increases massively. A young and dynamic vice-president at the local bank recognizes these customer debts as valuable future assets and increases Josh’s borrowing limit. He sees no reason for undue concern since he has the debts of the alcoholics as collateral. At the bank’s corporate headquarters, expert traders transform these customer loans into DRINK BONDS, ALKIBONDS and PUKEBONDS. These securities are then traded on security markets worldwide. Naive investors don’t really understand the securities being sold to them as AAA secured bonds are really the debts of unemployed alcoholics. Nevertheless, their prices continuously climb, and the securities become the top-selling items for some of the nation’s leading brokerage houses. One day, although the bond prices are still climbing, a risk manager at the bank (subsequently fired due to his negativity) decides that the time has come to demand payment on the debts incurred by the drinkers at Josh’s bar.
“Coles, in a high, shrill voice, demands payment from his alcoholic patrons, but being unemployed they cannot pay back their drinking debts. Therefore, Josh cannot fulfill his loan obligations and claims bankruptcy — his horses are sold without reserve at Keeneland but because they were cheap claimers that he overbred to big stallions they don’t even make stud fee. DRINKBOND and ALKIBOND drop in price by 90 percent. PUKEBOND performs better, stabilizing in price after dropping by 80 percent. The decreased bond asset value destroys the bank’s liquidity and prevents it from issuing new loans.
“The suppliers of Josh’s bar, having granted him generous payment extensions and having invested in the securities, are faced with writing off his debt and losing over 80 percent on his bonds. His wine supplier claims bankruptcy, his beer supplier is taken over by a competitor, who immediately closes the local plant and lays off 50 workers. The bank and brokerage houses are saved by the Government following dramatic round-the-clock negotiations by leaders from both political parties. The funds required for this bailout are obtained by a tax levied on employed middle-class non-drinkers.”
Finally. . . an explanation I can understand!